Monthly Archives: May 2007

The Transkaryotic Appraisal Litigation

This post is by Mark A. Morton of Potter Anderson & Corroon LLP.

My partner Arthur L. Dent has released this Memorandum on Chancellor Chandler‘s recent decision in the Transkaryotic appraisal litigation.  The Memorandum provides a detailed analysis of the decision and its implications for appraisal proceedings.

Corporate Governance and the Sale of VC-Backed Firms

This post is by Jesse Fried of Harvard Law School.

Brian Broughman and I have written a paper, Deviations from Contractual Priority in the Sale of VC-Backed Firms, that examines how corporate governance arrangements in VC-backed firms that are sold affect the allocation of the sale proceeds between preferred shareholders (the VCs) and common shareholders (including the founders, employees, and angel investors).

It is often assumed that VC cash flow rights–including their right to liquidation preferences when the firm is sold–are fully respected.  However, we are unaware of any study that examines whether VCs’ contractual priority rights over common shareholders are, in fact, fully respected.  And there is reason to suspect that they may not be.  In other settings, such as bankruptcy, common shareholders are sometimes able to use holdup power to extract part of creditors’ cash flow rights, causing a deviation from contractual priority.  To the extent that common shareholders in a VC-backed firm have holdup power, they may similarly use that power to “renegotiate” the parties’ cash flow rights.

To investigate common shareholders’ ability to extract part of VCs’ liquidation preferences, we use a hand-collected database of 42 VC-backed Silicon Valley companies that were sold in 2003 or 2004 and, at the time of sale, had both preferred and common stock outstanding.  We find that in a majority of sales, VCs are able to receive the full amount of their cash flow rights.  However, they receive less than their contractual entitlement in over 25% of transactions.  The average carveout in these cases is approximately 11% of the VCs’ contractual payout rights.  In the aggregate, the VCs in our sample give up approximately 2-3% of their cash flow rights to common shareholders.

We also show that the likelihood and magnitude of deviations from contractual priority are larger when VCs have less power in comparison to common shareholders.  Deviations favoring common shareholders are more likely to occur and to be larger when VCs lack board control: When the selling CEO is not a professional hired by the VCs but rather a founder (and therefore more likely to use his positional power to assist common stockholders).  However, the finding that may be of particular interest to lawyers is that the expected carveout to common shareholders is higher when the firm is incorporated in California rather than Delaware.  While there is some evidence suggesting that, within the U.S., state corporate law affects the value of common stock in public companies, our study may be the first to demonstrate that the choice of corporate law affects financial outcomes in private firms.

Brian and I are continuing to work on this paper and a number of related projects, so any comments would be most welcome.

Go-Shops: Market Check Magic or Mirage?

This post is by Mark A. Morton of Potter Anderson & Corroon LLP.

I recently submitted a new paper, Go-Shops: Market Check Magic or Mirage? for a panel entitled Selling to Private Equity at the 27th annual Ray Garrett Jr. Corporate and Securities Law Institute, hosted by the Northwestern University School of Law.  The article traces the evolution of “go-shops,” discusses the alleged advantages of using a “go-shop,” and suggests that there are a number of circumstances in which a “go-shop” will not materially improve the sales process.  In addition, the article includes a chart summarizing the material terms of every “go-shop” provision used in a public deal since the device first appeared.

Bebchuk Elected to Presidency of American Law and Economics Association

In its annual meeting this month, the American Law and Economics Association elected Professor Lucian Bebchuk as its president.  He will serve in this role until the Association’s annual meeting next spring.

In accordance with the Association’s traditions, Bebchuk delivered a presidential address at the ALEA’s Annual Meeting last weekend entitled Self-Regulation and the Public Corporation.  The address reviewed and reflected on Bebchuk’s work on the subject over the years.  This work includes, among other pieces, Bebchuk’s articles The Debate on Contractual Freedom in Corporate Law; Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments; Federalism and the Corporation: The Desirable Limits on State Competition in Corporate Law; A New Approach to Takeover Law and Regulatory Competition; Federal Intervention to Enhance Shareholder Choice; Optimal Defaults for Corporate Law Evolution; Asymmetric Information and the Choice of Corporate Governance Arrangements; Why Firms Adopt Antitakeover Arrangements; Executive Compensation as an Agency Problem; and The Case for Increasing Shareholder Power.

Proposed Amendments to the Delaware General Corporation Law

Editor’s Note: This post is by Lawrence A. Hamermesh of the Widener University School of Law. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

This year’s round of proposed amendments to the Delaware General Corporation Law, introduced on May 8, unquestionably falls a little short in the excitement department, at least compared to last year’s amendments (particularly those relating to director elections and retirement policies).

In the current crop, the most notable changes are to the appraisal statute.  Under these proposed amendments:

–Petitions for appraisal can be filed by beneficial owners, rather than only by stockholders of record (although demands for appraisal must still be made by record owners).  The Depository Trust Company will surely be relieved not to have to serve as a nominal petitioner in every public company appraisal suit.

–Reference to a “national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc.” has been deleted from the so-called “market out,” in light of last year’s reorganization of the NASDAQ stock markets.

–Most notably, there is to be a presumptive approach to awarding interest in appraisal proceedings.  Ordinarily, interest is to “be compounded quarterly and shall accrue at 5% over the Federal Reserve discount rate (including any surcharge) as established from time to time during the period between the effective date of the merger and the date of payment of the judgment.”  This has been Delaware’s default legal rate of interest for some time, and has frequently been the basis for awards of interest in recent appraisal cases.  By making it the presumptive approach to awards of interest in such cases, however, it is hoped that unproductive litigation efforts on the interest issue can be avoided.  Under the proposal, however, the Court of Chancery still retains discretion, for “good cause,” to choose a different approach in awarding interest.

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Pandora’s Ballot Box, or a Proxy with Moxie?

The Securities and Exchange Commission yesterday held its first roundtable on proxy access, and Chairman Cox told the press that the Commission will propose a rule in the early summer on shareholder rights in the proxy process.  We’re very pleased to host the following commentary on these events from J.W. Verret, a recent Harvard Law graduate and Olin Fellow in Law and Economics who has written extensively on corporate governance matters.  Jay (who can be reached at jayverret [at] gmail.com) and I welcome your comments on his analysis below.

The shareholder empowerment battle originated as a brief sortie to develop a withhold vote capability in the early 1990s, but has since become more of an unending campaign.  The academic community has debated shareholder empowerment for several years, and the fight has recently been given new life.  The SEC is convening a series of roundtable discussions on proxy access and the Commission’s role in protecting the state-law voting rights of shareholders.  And yes, that is deja vu you’re feeling: Lucian Bebchuk has studied, in depth, the justification for proxy access, and indeed can be credited for much of the momentum behind the movement.

But another movement is already afoot to empower shareholders: majority voting for uncontested elections, which will seriously affect the calculus of the proxy access debate.  In August of 2006, the Delaware Legislature passed an amendment to the General Corporation Law that renders shareholder-approved bylaws that set the minimum number of votes necessary for an election victory unalterable by the Board absent shareholder ratification.  This post summarizes my findings on that issue in my article Pandora’s Ballot Box, or a Proxy With Moxie? Majority Voting in Delaware Corporate Elections, forthcoming in the May edition of The Business Lawyer.

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Chancery Rules on Appraisal Rights for Shares Acquired After the Record Date for Merger Votes

Editor’s Note: This post is by Lawrence A. Hamermesh of the Widener University School of Law. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Last Tuesday, Chancellor William Chandler handed down a short but long-anticipated decision in the Transkaryotic (TKT) appraisal litigation.  TKT shareholders approved the deal by the requisite majority of the outstanding shares.  Cede & Co., holder of record and a DTCC intermediary, voted 12.8 million shares in favor of the merger and voted against or abstained with about 16.8 million shares. 

The opinion addresses the appraisal rights, under 8 Del. C. § 262, of shareholders who purchased some 8 million shares held by Cede & Co. after the record date for voting on the merger.  TKT sought summary judgment on the appraisal petition, arguing that the stockholders seeking the appraisal had the burden of proving that their shares were not among those voted by Cede in favor of the merger.  That sort of burden would have been impossible to satisfy, since market purchases after the record date can’t be traced to specific shares, and there is therefore no way to “tie” specific shares owned by those seeking the appraisal to shares that were voted for (or against) the merger. 

In an important ruling, Chancellor Chandler concludes that the traditional statutory reliance on record stockholder status in appraisal cases works in favor of the appraisal seekers: as long as the stockholder of record formally demands an appraisal in a timely fashion (i.e., before a vote on the merger), the law is indifferent as to whether a predecessor beneficial owner sought to vote the shares in favor of the merger.

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ALEA Conference Goes Out In Style


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This year’s meeting of the American Law and Economics Association, hosted here at Harvard Law, wrapped up today with three different panels featuring the latest scholarship on corporate governance.  Today’s panelists offered papers on hedge funds, stock market efficiency, and executive pay, all cutting-edge subjects for those interested in corporate governance.  For those of you who couldn’t join us here in Cambridge, I provide below a brief summary of the authors’ presentations as well as links to the excellent papers we discussed today.

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Day One of the ALEA Conference: Debating Corporate Governance Reform

This weekend the Law School plays host to the annual meeting of the American Law and Economics Association, which offers two days of presentations on the latest work in law and economics scholarship.  This afternoon’s panel on corporate governance reform, hosted by Paul Mahoney, featured papers from top scholars on the dismantling of staggered boards, the effect of Sarbanes-Oxley on the cross-listing premia available to foreign issuers, and the effects of the 2003 mutual fund voting disclosure regulation.  All three pieces are great reads for those interested in corporate governance reform.

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Bebchuk’s and Kraakman’s Articles Make the Top Ten List

This year’s list of Ten Best Corporate and Securities Articles, selected by an annual poll of corporate and securities law academics, includes two selections from the Harvard Law faculty: Professors Lucian Bebchuk and Reinier Kraakman.  The articles were selected from a field of 450 pieces, and the selected articles will be reprinted in an upcoming issue of the Corporate Practice Commentator.  This is the seventh straight year that an article from an HLS professor has been honored, and the sixth year in a row that HLS has had multiple selections.

Bebchuk’s article, Letting Shareholders Set the Rules, was published in the April 2006 issue of the Harvard Law Review.  Kraakman’s article, Law and the Rise of the Firm, which he co-authored with Henry Hansmann and Richard C. Squire, was published in the March 2006 issue of the Harvard Law Review.

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